Cash & Career: The Perils of 'Off the Book' Jobs

From the Wall Street Journal | Mar 7, 2010 | By JONNELLE MARTE

Even last week's modestly upbeat jobs report hasn't altered the harsh truth facing millions of Americans: It's still ugly out there.

While Congress is trying to entice companies to start hiring again, many businesses have become used to working with leaner staffs. Some continue to eliminate jobs and cut back hours. Claims for unemployment benefits are up one week and down the next. The unemployment rate stands at 9.7%, with 36,000 jobs lost in February, the Labor Department said Friday.

Tim Foley

It's no wonder, then, that more and more of the unemployed and underemployed are doing whatever it may take to pocket extra money each week -- including, if necessary, "working under the table" for cash and then stiffing the tax man by not reporting all their income.

For some, it's a second or even third side job. For others, it's a way to supplement unemployment benefits that don't cover the bills while they look for permanent work -- a problem that briefly threatened to become even more acute last week when Republican Sen. Jim Bunning of Kentucky blocked for a few days a 30-day extension of unemployment benefits for 100,000 laid-off workers.

But whatever the reason, working for cash -- and misrepresenting your income to the Internal Revenue Service -- can have big financial and legal consequences. And the IRS has ramped up its enforcement of income-tax reporting over the past few years.

"Not only are you risking a huge amount of penalties by not claiming all your income, you're also losing out on a lot of the benefits," says Anthony Parent, founding partner of IRS Medic, a Wallingford, Conn., tax law firm.

If you're in this situation, here are some tips on how you can come clean, the penalties you'll pay -- and what it can cost you if you don't.

Paying It Back

Many workers can come clean simply by filing a late tax return or amending incorrect returns and paying the taxes, according to the IRS and tax attorneys. In some cases, if you don't have a W-2 form or pay stub, you can estimate income, says Donald G. Koch, a New York tax attorney.

Tim Foley

There are penalties, however. The late-payment penalty is 0.5% of the taxes owed per month. And the late-filing penalty is about 5% of taxes owed per month, maxing out at about 25%, according to the IRS.

"You can end up with a bill far bigger than any amount of money you ever made in any year," Mr. Parent says.

But attorneys say you can reduce or even eliminate penalties if you come clean before the IRS catches you or if you cooperate after you come under investigation. For example, a couple who came forward in 2007 about $40,000 they made in 2005 by selling herbal remedies found out they owed about $10,000 in back taxes, which increased to about $12,500 with penalties, says Mr. Parent. If they had been caught before voluntarily reporting the income, they could have been hit by penalties for misstating their income and civil fraud that could have doubled their tax bill to about $23,000 and left them open to audits for other years, he says.

The IRS says it can sometimes grant extensions or waive penalties in difficult circumstances, such as mental illness or medical emergencies. Job loss isn't considered a valid excuse for not filing, however. Most individuals who owe less than $25,000 in income taxes will be able to set up payment agreements with the IRS if they can't afford to pay the sum upfront, Mr. Koch says.

People with unreported income also will have to pay back any unemployment benefits received -- with interest. Unemployment-insurance programs are run by states, which set their own eligibility requirements and penalties for tax fraud.

Meantime, employers who don't correctly account for employees with the IRS are liable for withholding income tax and will owe Social Security and Medicare taxes for those employees, plus penalties. And they can be fined and penalized for aiding workers who fraudulently claim unemployment benefits.

The IRS generally doesn't recommend criminal prosecution of taxpayers who file or make arrangements to file late returns. But that may not be the case for those who haven't filed a return for numerous years or already have been flagged for investigation.

Attorneys and IRS representatives say criminal charges usually are reserved for high earners or public figures, such as celebrities or popular local professionals, as well as small businesses. Actor Wesley Snipes is out on bail while appealing a three-year jail sentence after being convicted on three misdemeanor counts of failing to file a tax return. Prosecutors said he owed $2.7 million in back taxes.

"They like cases where there will be some publicity, so they like to get celebrities, they like to get professionals," says Mr. Koch.

The IRS has up to three years after a tax return is filed to pursue taxpayers who omit income. That can go up to six years in cases where income is underreported by at least 25%. There's no limit when workers don't file a tax return at all or when fraud is involved.

Ding to Social Security Benefits

Working off the books also has a longer-term consequence: You risk reducing Social Security benefits or not qualifying for them when you retire or if you become disabled. And survivor benefits can be affected as well.

You need to work and pay Social Security taxes for at least 10 years to qualify for benefits, whose calculations take into account the average of the 35 highest annual earnings an employee makes in his or her lifetime. Those who record fewer than 35 years of work have an annual salary of zero factored in for years they don't work -- or work off the books. This lowers their 35-year average and overall Social Security benefits. So will underreporting income.

Not reporting income and failing to pay Social Security taxes also could affect disability payments. Employees must work a certain number of years near the time they get injured to qualify for disability payments.

To correct your work history, you must submit proof of earnings to the Social Security Administration. And you'll need to pay any Social Security taxes owed.

Write to Jonnelle Marte at jonnelle.marte@wsj.com